Archives For Economy

Emmanouil (Manos) Schizas

By Manos Schizas, senior economic analyst, ACCA

Basel III is the global framework governing the regulation of bank capital, liquidity and leverage, agreed in the aftermath of the global financial crisis of 2008–9. Its provisions will, for the coming years, determine the banks’ cost of capital and therefore the cost and supply of credit to businesses globally. In Europe, it is implemented through the regulatory package known as CRD IV, which sets out the following:

  • A new set of minimum capital requirements, much higher than those previously in place, aiming to ensure that financial institutions can remain solvent and able to support the real economy under adverse economic and market conditions.
  • A maximum leverage ratio that aims to ensure that fluctuations in asset values cannot easily wipe out financial institutions’ capital.
  • A set of liquidity requirements that aim to ensure that financial institutions can service their short-term liabilities even if some of their assets become illiquid or distressed or if access to interbank and wholesale credit markets is constrained.
  • A risk-based approach which weighs riskier assets more heavily than safe ones for the purposes of capital requirements and less liquid assets (or less secure sources of funding) more heavily for the purposes of liquidity requirements. Banks can use standard weights developed by regulators or apply their own, as long as they are based on substantial in-house historical data.
  • Provisions for a dual capital buffer that aim to rein in the supply of credit in boom times and achieve higher capitalisation under adverse economic conditions.

Suspiciously familiar

From the point of view of the accountancy profession, risk-weighted assets (RWA) work in a manner similar to taxable income. In principle, the rules create an obligation for regulated parties roughly proportionate to some systemic ‘footprint.’ More income, more tax liabilities; more risk, more capital requirements.

But in practice such systems always create incentives for regulated parties to swap activities that create a regulatory footprint for activities that, for whatever reason, do not.

In a recent working paper, OECD economist Patrick Slovik showed that, between 1991 and 2008, RWAs fell from 66% to 33% of major systemic banks’ total assets. The fall was very steady, and much of it was down to the falling share of loans. The most extreme example was Deutsche Bank – where loans made up 85% of total assets in 1990, but only 17% in 2005. On paper, banks were safer. In reality – well, we know what happened next.

No place for the little guy?

Who could blame banks for transforming themselves away from SME lending? In 2010, Capgemini calculated that small business loans (which are naturally riskier than loans to large corporates or government bonds), were responsible for 27% of the net income of major European retail banks, but 46% of their risk-weighted assets (and thus the associated capital charges). Indeed, in the more competitive banking sectors, most small business banking is not really profitable.

This is driving a wedge between two things that used to be synonymous – lenders’ appetite for SME loans as a product and investors’ appetite for SME credit as an asset class. While the former is flagging, the latter is still healthy – in surveys, banks seem confident of their ability to sell off portfolios of SME loans and even retail investors are piling into SME credit through peer-to-peer and crowd lending platforms. In the medium term, the best means of bridging this gap may be the mass securitisation of SME loans.

Jumping without looking?

The Basel Committee admitted from the outset that the impact of Basel III on SMEs might be disproportionate. Yet for two years there was no official impact assessment for the sector – so we called for one. To their credit, the European institutions responded with the Commission’s assessment in December 2011 and the European Banking Authority’s (EBA) assessment of SME risk weights in October 2012. Both missed the point.

The Commission assumed that the impact of CRD IV would be felt through higher interest rates or credit rationing, and were reassured when their models pointed to small effects. This ignores the resulting long-term changes to banks’ business models that should worry us more.

Likewise, the EBA assumed that the purpose of capital and liquidity regulation is to manage risk to individual institutions. They were reassured when their calculations showed that SMEs were riskier than large corporates. Yet the purpose of such rules should be to manage systemic risk – the kind that banks expose others to without internalising. By that measure, a AA-rated government bond posted as collateral is riskier than any small business loan will ever be.

It’s too late now for a wholesale review of Basel III or CRD IV. But perhaps the Basel Committee should use the relative quiet of the next six or so years to start preparing a Plan B.

This article was originally featured in Ziarul Financiar banking supplement, June 2013


By Errol Oh, executive editor of The Star

In some assessments of potential corporate offers or deals, independent advisers are discombobulating investors with seemingly ambivalent advice. It all boils down to the definition of two words.


Soon, the capital market and investors may require the expertise of etymologists, given the recent string of cases of independent advisers (IAs) concluding that proposed corporate exercises are ‘not fair but reasonable’.

Who can blame the minority shareholders of listed companies for feeling confused and powerless when presented with seemingly ambivalent advice? The IA tells them an offer for their shares or a deal is unfair, but in the same breath, it recommends that they accept the offer or vote for the deal because it is deemed reasonable.

It all began in March 2010 when the Securities Commission (SC) issued a consultation paper on offer documentation for take-over and mergers. In it, the SC noted that IAs have evaluated the fairness and reasonableness of offers as a matter of market convention, and that in Malaysia ‘fair and reasonable’ was treated as a composite term. It was also pointed out that there was no definition for the term.

The SC says, ‘The Commission is of the view that since the standard of ‘fair and reasonable’ is used to determine whether an offer should be accepted or rejected, it is important that such a standard be clearly defined and interpreted in a consistent manner.’

Through the paper, the SC proposed to advise IAs on the interpretation of what is ‘fair and reasonable’. Last November, the proposed changes became part of the SC’s Practice Note 15 (PN15) of the Malaysian Code on Take-overs and Mergers 2010. A key difference is that the term ‘fair and reasonable’ is now two distinct criteria.

Assessing fairness of a take-over offer is quantifiable: if the offer price is equal to or higher than market price, but lower than the value of the securities that are the subject of the offer, the offer is considered ‘not fair’. Conversely, a fair offer is when the offer prices are equal to, or higher than, the value of the securities. Reasonableness is a bit more challenging to establish. Say the PN15: ‘In considering whether a takeover offer is ‘reasonable’, the IA should take into consideration matters other than the valuation of the securities that are the subject of the take-over offer.’

The PN15 specifies five factors that IAs should consider when evaluating reasonableness, but it also reminds IAs that they are expected to take into account ‘all relevant factors’. The decoupling of ‘reasonable and fair’ has paved the way for IAs to recommend acceptance of an offer or approval of a proposed transaction even if it is considered not fair but reasonable. This is how it is explained in PN15: ‘Generally, a takeover offer would be considered ‘reasonable’ if it is ‘fair’. Nevertheless, an IA may also recommend for shareholders to accept the take-over offer despite it being ‘not fair’, if the IA is of the view that there are sufficiently strong reasons to accept the offer in the absence of a higher bid than such reasons should be clearly explained’.

Even with explanation it is hard for most investors to digest advice that they should support something that is described as unfair yet reasonable. IAs are meant to safeguard the interest of shareholders by enabling them to make informed decision on certain transactions. However, when investors find it difficult to take independent advice, it is neither a fair nor reasonable solution.

This article first appeared in Accounting and Business magazine, May edition, 2013.

By Cesar Bacani, editor in chief of CFO Innovation Asia

Having already made basic post-financial crisis cuts in headcounts, procurement and discretionary spend, companies are now coming under pressure to take more radical approaches.


In economically trying or uncertain times, the default response is to cut costs. We saw this happen in 1997, during the Asian financial crisis, and in the 2008 global financial crisis.

You would think that by this time, as the European crisis and uncertainty in the US continue to threaten Asia, business would have done all the cost-cutting they could absorb. Apparently you would be wrong.

‘A lot of the low hanging fruits are already gone,’ Nigel Knight, managing partner at Ernst & Young’s Advisory Services in Asia, recently told me. These include basic headcount management, working capital improvement around purchasing and procurement, and slashing discretionary spend such as travel and expenses (T&E).

But the pressure to cut remains intense. Resources firms in Australia, for example, and many enterprises in China face regulatory headwinds and slowing economic growth. With the top line stalling, companies must improve their bottom line to keep shareholders happy.

What consultants like Ernst & Young are seeing, says Knight, are companies moving to a new ‘level of sophistication’ in cutting costs. ‘For example, T&E spend was traditionally just putting arbitrary controls on travel,’ he notes. ‘Now the initiatives that are taking place are much more analytics-based’.

The Big Four firm is working with a large pharmaceutical firm to harness analytics, and track and analyse T&E spending in all business units across the region to find a way to leverage on total spending to maximise discounts on hotel nights, for example, flights and telecom expenses.

A similar approach is being applied to shared services. The first round of cost-cutting involved outsourcing basic finance and procurement activities. ‘Now we’re seeing another round’, says Knight, ‘which is extending the scope,and also using the information to generate further reductions.’

Another effort focuses on the supply chain. ‘There’s a lot of fat to take out’, says Knight, ‘just in the way in which companies globalise spending between countries and also in manufacturing strategies. There’s quite a push even in China, which is becoming more expensive, to move manufacturing capability to Vietnam, Laos and so on’.

‘Multinationals are also looking at their processes much more from an end-to-end perspective, looking to simplify and standardise core processes – procure-to-pay, order-to-cash, and so on – right across the business. They are trying to take advantage of savings not generated in individual business units or countries, but across geographies and business units’.

At this point, I could almost expect cloud computing services providers to chime in, software-as-a-service purveyors, managed IT services guys, teleconferencing providers, business intelligence and analytics software makers…

For plucking the cost-cutting fruits higher up on the tree can mean spending money first for new infrastructure, software and expertise – which may end up costing more if the implementation is not done right. The consultants will be there to help, but they, too, will require paying.

‘You need to spend to save,’ argues Knight. Maybe. The business will be depending on finance professionals to make sure the more sophisticated ways of cost management do not use more money and other resources than the savings they will bring in.

This article first appeared in Accounting and Business magazine, May edition, 2013.

Off the hook

aksaroya —  17 May 2013 — Leave a comment

Peter Williams, accountant and journalist, explores the contrast between the impassioned scapegoating of the ratings agencies during the onset of the financial crisis with the meek acceptance of the recent UK sovereign downgrade.


Credit-rating agencies have proven remarkably capable of withstanding the opprobrium of politicians. At the start of the financial crisis, politicians pilloried the agencies, and warned of dire consequences for their part in the crisis. But the tough talk has barely touched the work and the output of the rating agencies.

Perhaps inevitably, the discomfort of a UK sovereign downgrade from its coveted AAA status by the rating agencies has been seen partly through the prism of the political damage inflicted on UK chancellor George Osborne. But he is not alone: the UK has merely followed in the footsteps of the US and France in 2011 and 2012. A few weeks before Moody’s delivered its ratings verdict on the UK economy – and some would say on the chancellor’s stewardship – European politicians delivered theirs on how rating agencies should act in future. Those judgements could hardly have been more different.

The new EU rating agency rules amount to little more than an invitation to carry on as before. The final package aims to reduce the over reliance on ratings and make it easier to sue the agencies if they are judged to have made errors when, for example, ranking the creditworthiness of debt. In particular, the agencies will have to be more transparent when they are rating sovereigns, respect timing rules on sovereign ratings and justify the timing of publication of unsolicited ratings of sovereign debt. The politicians’ stance softened markedly during negotiations with the agencies. The proposal for a state-funded agency was quietly shelved. It is a far cry from the blood and thunder that politicians were threatening back when the financial crisis was still raw and unfolding. The mood then was summed up by US politician Henry Waxman, who declared: ‘The story of the credit-rating agency is a story of colossal failure.’ The agencies’ failure to spot the problem with securities had broken the bond of trust and put the entire global financial system at risk. They were told to expect a radical overhaul, perhaps an entirely new system. The House of Lords report into the agencies in July 2011 was tellingly entitled Sovereign Credit Ratings:shooting the messenger?

Shooting the Messenger?

The four-month inquiry criticised the agencies’ role in the 2008 banking collapse but concluded its EU sovereign downgrades ‘merely reflected the seriousness of the problems in some member states’. The politicians’ overall view on the agencies? They should learn from their past failure to spot emerging risks. Well, yes. A little later, at the height of the Eurozone crisis in August 2011, one leading politician agreed with the Lords’ stance: ‘Credit-rating agencies, however imperfect, are trying to give market investors some idea of the creditworthiness of economies and businesses. They did not cause this.’ Such a view is perfectly reflected in the light-touch ratings agency regulatory regime now swinging into operation. The politician who struck the conciliatory note of reality? Yes, you guessed it: he of the recent credit downgrade, UK chancellor George Osborne.

This article first appeared in Accounting and Business magazine, UK edition, April 2013

The weaknesses of the credit ratings system are only too clear, but finding a way to address the conflict of interest issues without generating new problems is anything but straightforward, says Ramona Dzinkowski, economist and business journalist


Since the Dodd-Frank Act of 2010, the US Securities and Exchange Commission (SEC) has had a multitude of objectives aimed at improving investor security in the US. One of the most important is to recommend a better system for rating securities to eliminate the potential conflict of interest between issuers and agencies while also taking measures to possibly eliminate investor reliance on the agencies altogether.

The crux of the matter is the issuer pays model, which is used by the vast majority of credit rating agencies. An agency is paid by an issuer for rating its security and the issuer generally then makes its credit rating publicly available for free. According to many observers, this creates an incentive on the part of the agencies to issue favourable ratings or delay possible downgrades. Ultimately, it’s seen as one of the many related problems underlying the financial crises of 2008.

In its December 2012 report to Congress on assigned credit ratings, the SEC reviewed a series of possible payment options for the agencies, including a model proposed by Congress whereby the SEC acts as middleman between issuer and agency. In other words, securities issuers will no longer be able to select their own rating agencies. The possible outcome of such a system has been the subject of much debate. For some, removing the choice of agency is a simple solution to the conflict of interest problem. However, others see it as a much more complicated issue, an affront to the free enterprise system as we know it, and a possible violation of the First and Fifth Amendments.

Meanwhile, the SEC is a long way down the road of removing requirements and references to rating agencies in its rules in an effort to eliminate the reliance on external agencies. The December 2012 SEC report declares: ‘Reducing reliance on credit ratings could mitigate conflicts of interest to the extent that it causes investors to use factors other than credit ratings to make investment decisions. If credit ratings are no longer used in statutes and regulations to confer benefits or relief, the incentive to obtain credit ratings that meet these requirements should be eliminated.’

For me, taken together, this presents an intellectual dilemma. On the one hand, Congress has taken measures to minimise the reliance on rating agencies by requiring the SEC to remove references to them in its rules; on the other, it proposes to increase their perceived or ‘endorsed’ credibility by having the SEC independently assign agencies to rate new issues. What is the policy direction here?

Also, there’s the lingering question of how these assignments would be made, given the annual SEC review of the agencies. Would the best agency win, all the time, resulting in a preferred agency with better compliance results being assigned a greater number of new issues, on average? Would this ultimately improve agency performance, or boost the market power of one of them in an already monopolistic industry? In addition, how many new SEC personnel would be required to administer the new system with its potential thousands of new complex releases every year?

There are still more questions than answers here. The SEC is currently organising a public roundtable to invite discussion from supporters and critics of the possible alternatives.

This article first appeared in Accounting and Business, International Edition, April 2013